Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Nancal Technology Co.,Ltd (SHSE:603859) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Nancal TechnologyLtd's Net Debt?

As you can see below, at the end of September 2024, Nancal TechnologyLtd had CN¥196.3m of debt, up from CN¥81.9m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥609.5m in cash, so it actually has CN¥413.2m net cash.

How Healthy Is Nancal TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Nancal TechnologyLtd had liabilities of CN¥1.21b due within 12 months and liabilities of CN¥93.6m due beyond that. Offsetting this, it had CN¥609.5m in cash and CN¥1.63b in receivables that were due within 12 months. So it actually has CN¥931.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Nancal TechnologyLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Nancal TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Nancal TechnologyLtd's load is not too heavy, because its EBIT was down 36% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Nancal TechnologyLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Nancal TechnologyLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Considering the last three years, Nancal TechnologyLtd actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Nancal TechnologyLtd has CN¥413.2m in net cash and a decent-looking balance sheet. So while Nancal TechnologyLtd does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Nancal TechnologyLtd has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.